Twelve out of 20 commercial banks have experienced a decline in profits compared to the second quarter of the previous fiscal year.
For a while now, there have been concerns about the profitability of Nepali commercial banks. In the first half of the last fiscal year, when banks' interest rates reached double digits amidst a liquidity crunch, there was considerable criticism about banks prioritising profits over the needs of their customers. Many customers encountered difficulties in obtaining loans, compounded by the burden of rising interest rates and banks' strict measures on loan recovery. Many people were concerned about the profitability of commercial banks, particularly as many businesses struggled to stay afloat amid the country's economic downturn. Some members of society questioned how banks were able to make high profits when companies borrowing from them were facing losses. The performance of banks in the second quarter of the current fiscal year, however, reveals a concerning trend. Commercial banks saw their profitability go down by 28%. Twelve out of 20 commercial banks experienced a decline in profits compared to the second quarter of the previous fiscal year, with one commercial bank even reporting a negative return.
Bad loans arise when borrowers fail to repay according to the loan terms. In the past, banks typically set targets and managed to meet them each year. This year, however, was different with the majority of banks reporting profits below their target levels. Given the economic downturn, businesses faced significant challenges in generating profits. The decline in economic activities has profoundly impacted various sectors, including clothing shops, hardware stores, restaurants and educational institutions. With the money cycle disrupted, businesses found it difficult to service their loans on time which resulted in a surge in non-performing loans (NPLs) in the banking system.
For a while now, the rate of internal borrowings such as treasury bills, bonds or the interbank rate has been at a lower level. The interbank rate recently dropped to as low as 1%, indicating that banks had limited investment opportunities in recent times. The Nepal Rastra Bank (NRB) introduced a Statutory Deposit Fund last month which is expected to stabilise the rate. Currently, there isn't high demand for loans compared to deposit accumulation. This has not only resulted in low loan demand but also led to difficulties in repaying existing loans for businesses. Both rumours and the behaviour of banks have contributed to a situation where clients are not being able to service their loans on time. There have been numerous rumours circulating about the possibility of loan amounts being waived off. Campaigns against banks and financial institutions may provoke borrowers to delay repayments. These rumours could have influenced some borrowers to postpone their loan payments. Additionally, the practice of waiving interest for those who pay back the entire year's instalment and interest at once in the last month of the fiscal year has continued from the previous year. This practice may lead borrowers to question why they should pay their loans in the first quarter when they can receive a discount by paying late.
With the money cycle disrupted, businesses found it difficult to service their loans on time which resulted in a surge in non-performing loans (NPLs) in the banking system.
The pursuit of profits to impress investors has fostered a culture where banks prioritise profit over service offerings. Consequently, loans are sometimes disbursed without proper risk assessment. Bad loans undermine market confidence, while a high concentration of bad loans poses systemic risks that can jeopardise the entire financial system. This situation attracts regulatory scrutiny and necessitates interventions such as imposing capital requirements and restrictions on lending activities to mitigate risks. There is significant pressure from political factions and influential figures in loan disbursements. Corporate-level corruption has played a role in influencing loan disbursements and approving limits beyond total capacity. Political interference in selecting management and board members exposes such incidents to consequences. Loopholes for corruption during loan disbursements often go unnoticed. This ultimately leads to the emergence of bad loans. Inadequate audit competence further exacerbates these situations.
The primary impact of bad loans is directly visible on the balance sheet and this adversely affects the bank's overall performance and profitability. A high level of Non-Performing Loans (NPLs) creates a crisis scenario. It significantly impacts credit supply and demand, which, in turn, reduces lending to the real economy when it is needed the most. Borrowers struggling to repay loans exacerbate the crisis, leading to lower growth levels in investment and a drastic reduction in banks' lending capacity. This situation may require banks to focus on raising capital, while also facing spillover effects in foreign markets, resulting in enhanced reputational risk. Consequently, even if interest rates are lowered, banks may remain cautious about lending.
The negative perceptions of banks among the public can lead to reduced savings, posing a serious concern for the economy. Bad loans not only erode a bank's capital base but also have the potential to instigate panic-filled situations like credit crunches. If bad loans result in tightened credit conditions, there may be pressure on interest rates as well. Furthermore, bad loans can significantly contribute to negative economic growth and diminish investor confidence. The collapse of US banks serves as a poignant example in this regard.
(Regmi is Deputy Manager at Rastriya Banijya Bank Ltd)
